Weighing up the pros and cons - choosing your business structure
There are four principle business structures available to SMEs in the UK:
- A sole trader
- Limited liability partnership (LLP)
- Limited company
We recommend that you take the time to understand the nuances of each approach, so you make the best choice for the long-term viability of the business.
- Sole Trader
Sole traders, are owned and run by a single person (although you can hire employees). These are inexpensive to setup and put you completely in the driving seat. You will make all of the decisions regarding the setup and operation of the business and you are legally responsible in all respects. Some of the key points to consider of being a sole trader are:
- You keep all profits after you have paid tax on them (you will pay income tax and National Insurance)
- You are personally liable if there are any financial losses
- HMRC will require you to complete a self-assessment each year
- If your turnover more that £85,000, you will need to register for VAT
Under a traditional partnership, two or more people share both the responsibility for owning and running the business, and they will share the profits. Partnerships are an ideal way to pool setup capital, experience, knowledge, and skills. The legal relationship of the owners will be clearly laid out in a partnership agreement.
Such business structures are subject to the (now rather ageing) Partnership Act 1890, which requires that, unless otherwise stated in the partnership agreement, the partnership must be formally dissolved on the death or retirement of any one of the partners; and even if one partner decides to give notice to the others. A Partnership Agreement is therefore vital to ensuring that the interests of those invested in the business are formally documented. The key points of traditional partnerships to consider are:
- All partners share the responsibilities and liabilities of the business
- Untaxed profits are shared equally, and each partner must tax on their portion (by filing a self-assessment with HMRC); as such the tax arrangement are typically straightforward.
- A partner can include a limited company, acting as a ‘legal person’
- There is no legal obligation for a partner to play a role in running the business
- Limited Liability Partnerships (LLPs)
LLPs are the same as traditional partnerships, however the liability of each partner is limited (rather like a limited liability company). This is typically the preferred business structure for professionals such as solicitors, accountants, and architects. The key points to consider are:
- LLPs can enter into business contracts, borrow money, and purchase property
- LLPs use a limited liability partnership agreement to formally document how profits will be shared, who will make decisions, the responsibilities of each member, and they can depart or join the partnership
- LLPs are registered with Companies House, unlike traditional partnerships
- Financial accounts must be registered each year with Companies House
- Tax is paid personally by each partner – which may be higher than for a traditional company
Having a Partnership Agreement drawn up is still essential for LLP arrangements, as this will set out how the partnership will be run. A Partnership Agreement can include clauses governing:
- The duties and responsibilities of each partner
- The amount of capital each partner has contributed
- A disputes resolution clause
- How the profits will be shared
- What happens if one partner resigns, retires or dies
- Limited Company
The main difference between a limited company and partnerships and sole traders is the legal and financial liabilities and obligations of a limited company are distinctly separate from that of the individuals. Under this model, the company will pay corporation tax – this is currently 19%. The government plans to drop this rate to 17% by 2020. The key points to consider regarding limited companies are:
- The process of setting up (incorporating) a limited company is very simple. Once you have decided on your company name, the registered address, who the directors will be, how the shares will be divided, you will then need to complete two key documents:
- Memorandum of association – a legal document signed by all shareholders agreeing to form the company
- Articles of association – a set of rules which define how the company will be run
Following this, the company must be registered with Companies House. You will also need to register the company for Corporation Tax with HMRC. It should be noted that an accountant can complete the registration on your behalf, thereby keeping your administration tasks to a minimum.
- You are only liable to the extent of the amount of money you have invested
- Limited companies typically have more credibility which will be more attractive to customers and investors
- There is essential paperwork involved with running a company, and accounts must be filed each year – however with the aid of a good accountant, this is a minimal overhead.
Forbes ranked the UK 1st out of the top 25 countries for ease of doing business. A large part of this is due to the lack of red tape incurred when setting up a new entity. But while the process of setting up, and the administrative overhead of running a business is minimal, it is still crucial that you take the time to understand which business structure is best for your venture. Getting it right from day one will ensure you enjoy the many benefits of running your own business.
Guillaumes LLP Solicitors is a full-service law firm based in Weybridge, Surrey. We have a highly experienced commercial law team who can assist you with setting up your new business entity. To make an appointment, please call us on 01932 840 111.